Podcast: Play in new window | Download
Subscribe: RSS
Hold on a second, we’ve changed our minds. Can you just hold it right there, please? We’ve decided we like it the way it is…..
The economy of the United States and the world is on fire, and with the flames and smoke visible in any direction one cared to look, the President of the United States declared last night that the worst is over, “the shadow of crisis has passed,” and happy days are here again. In reality (a state that presidents and candidates for president never seem to visit) 2015 is shaping up to be one of the worst any of us have ever seen.
It’s a potent mix of flammable situations, from an unhinged stock market to a drought-ravaged West to the fiscal convulsions of China, Russia and Europe. But for us in America, the collapse of the bogus New American Oil Revolution is the fire that’s burning hottest and spreading fastest. This is how it’s likely to go:
First, drill rigs are being shut down and workers laid off, especially in the fracking plays; as unemployment rises and income declines, production will start to fall; as fracking-company stock prices tank, their junk bonds will become worthless and their leveraged loans will go into default, their money sources will dry up and fracking production will virtually halt; as similar problems beset the legacy oil business world wide, the entire edifice of energy junk bonds, derivatives, hedges, credit default swaps and rabbits’ feet will collapse and the stock market will crash. Welcome to The Great Recession: the Sequel.
So, how are the frackers doing on Day 21?
1. Laying down rigs, shedding people.
- In October of last year, America had 1609 active oil rigs working. We’re down to 1366, and the last one-week decline was the largest since the last crash in 2008.
- The giant provider of oilfield services Baker Hughes announced yesterday it will lay off 7,000 employees, or 11% of its staff. CEO Martin Craighead said “we are taking proactive steps to manage the business through these challenges.” Which translates from PR-Speak as “Run! Run for your lives!”
- Another giant provider of oilfield services, Halliburton (which is about to acquire Baker Hughes) announced it will be laying people off but would not provide a number. Halliburton cut a thousand jobs in the last quarter of 2014.
- And the world’s biggest provider of oilfield services, Schlumberger, announced a few days ago it will cut 9,000 jobs, 8% of its workforce, after reporting fourth-quarter 2014 profits that were just 18% of the profits they racked up in the same period of 2013.
- North Dakota, responsible for nearly half the oil-fracking revolution in the United States, has been booming since development of its Bakken oil-shale formation hit stride in 2000. According to United Van Lines’ Annual National Movers Study, North Dakota now has the country’s fourth highest outbound migration rate.
2. Production Reduction
Those who are pumping oil have to keep pumping oil as long as they can. Simply stopping production and waiting for prices to rise is not an option because they are deeply in debt and mired in contract obligations. They may be only running in place, but if they stop running they vanish. So we won’t be seeing actual drops in production for a few months. But here’s how we know they’re coming.
The Bakken play in North Dakota is about 40% of the “new American oil revolution.” Its production has gone from 500 barrels per day in 2008 to just over a million barrels a day. They had to drill 6,000 wells to do that. The Achilles Heel of the fracking revolution is the hideous decline rate of fracked wells: production declines by about 90% in just three years. So if they drilled another 6,000 wells in the next three years (at an average cost per well of $8-$10 million) all they would do is keep production at a million barrels a day. And that’s assuming they found as many “sweet spots” in the next four years as they did in the last. And you can’t assume that. It’s also assuming they can find the cheap money — the junk bonds and junk stock and junk loans — that financed the first 6,000. And you can’t assume that.
To put it another way, if no new wells were drilled in the Bakken in 2015, by the end of the year its production would be about 550,000 barrels a day, or one half its current production.
3. To follow the money, you have to find it.
It was possible to satisfy the enormous appetite of the fracking industry for cash (see “decline rate”) as long as oil prices were high, money was cheap, and the Masters of the Universe were delirious about America achieving “energy independence” and becoming “number one in oil” again. The Masters are still delirious, but nothing else is true.
In the past, the oil companies either sold stock, issued bonds, or took out loans to stay on the drilling treadmill. How’s that working out for them? The Bloomberg index of North American oil producers finds that since last June, their value has declined by over half and their debt has increased by 85% — hardly a sustainable trajectory. Going public, up until last year a sure-fire way to cash in big and finance whatever the hell you wanted to do, is simply not an option in 2015. Not for anybody in the fracking oil business.
As for debt, interest rates on junk-rated energy bonds are over 10%, double what they were last June. Previously issued bonds are trading on the secondary market for dimes on the dollar. And more than 20 US exploration and production companies have used 60 per cent of their credit lines, according to Bloomberg.
A financial situation for frackers that could best be described as sour now will turn completely rancid in April (at the latest). That is the month that lenders conduct one of two annual reviews of the collateral they are holding for their lines of credit. Typically, the frackers turn to lenders only after exhausting the possibilities of issuing stock and junk bonds, so by the time they get to banks they need what are politely referred to as leveraged loans, or loans to a company that has all its assets locked up and is hemorrhaging cash. When the bankers review the cinders of the assets they accepted as “security,” there are going to be some cardiac arrests.
At that point the Crash of 2015, if it hasn’t already, will metastasize.
[UPDATE: DAY 22]
According to a story in Bloomberg News, which is not exactly one of your fringe Doomer news sources, not only oilfield service providers but oil drilling companies themselves are going to “begin to die” in the second quarter of 2015 as bigger and bigger dominoes fall toward a crash. The January 22 story begins:
Oil drillers will begin collapsing under the weight of lower crude prices during the second quarter and energy explorers who employ them will shortly follow, according to Conway Mackenzie Inc., the largest U.S. restructuring firm.
So long as an evil deed has not ripened, the fool thinks it as sweet as honey. But once the evil deed ripens, the fool comes to grief. (Dhammapada 69)
Confucius said: The door is the exit. Why does no one want to use it? (Analects 6:15)
Bizarre things happening to the copper price:
1/19: Morgan Stanley proclaims “copper will rise”
http://www.bloomberg.com/news/2015-01-19/morgan-stanley-sees-24-rally-in-copper-after-last-week-s-slump.html
1/20: Shill pieces proclaim that “copper is rising now because of China” (China which just had its worst year since 1999)
http://www.bloomberg.com/news/2015-01-20/copper-in-london-advances-before-china-economic-data.html
http://af.reuters.com/article/metalsNews/idAFL6N0UZ1AL20150120
http://www.brecorder.com/markets/commodities/europe/218678-copper-base-metals-climb-as-china-growth-data-brings-relief.html
http://www.proactiveinvestors.com.au/companies/news/60227/copper-advances-on-positive-chinese-economic-data-60227.html
Copper-related stocks were dumped on 1/12-14 but have been recovering since then. One (SCCO) recovered its full December value.
There appears to be a dangerous amount of posturing going on. As I noted earlier this week, day traders and hedge fund managers are drowning in cheap money from QE, and seem determined to pump up the price of anything that seems even a little deflated.
BTW, tucked inside a gloom-and-doom story:
“Hiring from oil-producing states such as Texas, Oklahoma and North Dakota has accounted for 67 percent of U.S. jobs growth since 2007, data compiled by Bloomberg show.”
http://www.bloomberg.com/news/2015-01-20/bond-investors-haven-t-been-this-gloomy-since-2008-but-are-they-right-to-be-so-down-.html
Why is any of this being cast in a negative light? This is all very good news!
Fracking = a disastrous and stupid idea. Close them all and stop ruining the groundwater.
Capitalism = one of the dumbest ideas of the human race.
Endless growth = the great destroyer of the Earth and future habitability.
Halliburton = a company that exemplifies the word ‘evil’. Glad to see it decline!
This website is being piloted by an idiot. Decline is GOOD and way overdue.
Why is this being cast in a negative light? Here’s why:
http://www.reddit.com/r/AskReddit/comments/2sbi17/what_do_insanely_poor_people_buy_that_ordinary/
It is clear that a way to a genuine future cannot be found within current paradigms
“When the bankers review the cinders of the assets they accepted as “security,” there are going to be some cardiac arrests.”
Don’t think so. They will simply present the check for their gambling losses to the U.S. treasury for payment. That has already been arranged by the bill that passed congress (at the urging of the White House and Wall Street) in December. Thanks to Obama, it’s the American people who are on the hook here. Essentially, we will all be subsidizing the fracking industry as they struggle through this patch of $50 oil. Aren’t we nice?
Gosh, the amount of analysis and postulating is staggering. The only thing we know for sure is that much of this is a house of cards and there are big problems and challenges out there. I know folks are using the data that is available to make these various bold predictions, but in reality, no one knows how things will really play out. After all, there are always unpredictable forces at work, such as governments doing all types of crazy things–like subsidizing failure, printing worthless money, and much more–all smoke and mirrors, but nonetheless things that can impact outcomes.
Before I am accused of not reading history, let me assure you I do. During the crash of 1929, the dust bowl, the rise and threat of communism to our national survival, the nuclear threat hanging over our heads, etc.there were also many bold predictions about the end of the world literally, or at least as we knew it. Books and articles were written, speeches delivered, and a general wringing of hands in all corners of this land. Many, if not most, of the predictions and scenarios were wrong. We are still here. (And, yes, I understand it was a different world…)
Based on that, I am having a difficult time getting too excited about the end of the world or some catastrophic collapse because we don’t really know how things will work out and the real impact on us. I know that many will disagree with me and ask how I can talk like this in the face of such overwhelming evidence about the alarming and bad things that are happening. To them, all I can say is that I am worrying about it as fast as I can, but as yet I have no real or practical solutions.
Just to be clear (and although I’ve explained it elsewhere, I should probably make this a standard disclaimer), I do not believe that the Crash of 2015 will be the end of the world as we know it, just another garden-variety 2008 Great Recession. Which, by the way, I saw coming in 2005, and wrapped up a real-estate business just in time to get out of the way. Then, as now, people constantly told me how futile it was to apply logic and common sense to the doings of the Masters of the Universe, who knew what they were doing with sub-prime loan derivatives, and were surely right when they told us that the price of real estate would never ever go down. (Before that, I heard the same thing about the Savings and Loan guys, the boys of Enron, and the Dot Com geniuses.)
I was also in the real estate business when another Black Swan event — the second oil shock of 1979 — changed everything. At that time I believed that, as you say, nobody really knows what’s going on and the people who had been warning us since the 1973 embargo had been wrong again and again. (One of them was President Carter, and we were about to throw him out of office for being so negative.) So I didn’t see anything coming, I wasn’t worried, and it wiped me out. I resolved that thereafter, I would worry more.
Thank you, Tom. I understand and applaud you for raising the alarm when the smoke is probably signalling a forthcoming fire. (What is unknown is whether it results in a 2 or 6 alarm fire.) No matter, your writing and presentation are powerful and flawless. And, putting facts and analysis out there is a valuable service for people to at least consider.
For me the devil has always been in details. Yes, bad things can and will happen, but how will their unfolding impact the average bloke like me? The problem I have is that my crystal ball too often seems murky at best as to the real outcome.
I agree that there are some signs that signal really bad and often predictable news and outcomes. For me, like you, the real estate bubble was one. I never thought it was a good idea to sell someone a $400,000 house when their real income was less than $40,000. Someone was going to default and someone was going to ultimately lose money.
That said, when it comes to investing, there is, of course, always risk and those who seek the ‘too good to be true’ returns lose money. Unfortunately, the government seems to believe that it is their role to protect folks from their personal investing folly. In reality, though, people who invest and lose money need only to look in the mirror for who is responsible. If they invest and make money the same applies.
That aspect of life is somewhat predictable because it is based on individual choices. What is not so predictable are the essentials we need to survive and depend on that are often beyond our control,like energy and food. The forces that drive those markets are less predictable, especially when there is so much potential for the masters of the universe and the government to rig the game. That is the truly scary part for most people because the ultimate outcome is much less certain and much less in the hands of individuals. So, for me, determining the outcome and impact as they unfold remains sketchy at best. These are Just my opinions and thoughts, but I appreciate and enjoy hearing what others think and believe.
Tom, I would like to see your take on what will happen when the fed bails the banks out this time. It seems obvious that they will have to do something. The $200 billion in junk bonds can be obviated in one instant of money printing, but what does that do for the future?
It seems that at that point, the Fed would be in the oil business?
A fracker that just had his worthless junk bonds purchased by the Fed would issue ten times as many that would be snapped up by the same people (1 percenters) that just sold the old ones to the Fed? , at a profit?
The old rules no longer seem to apply.
This seeks to take me further into the back office of the Grand Casino than I am qualified to go, but here’s my casual, un-researched response: I do not believe that the Fed can buy junk bonds, most of which are owned by wealth managers desperate for a higher rate of return. Leverage loans are another matter, most of those have been made by banks with FDIC-covered deposit accounts, so they could, thanks to last year’s Congress, be made whole by the taxpayers. I do not think the Masters of the Universe are going to be able to pull this one off much longer.
Yeah, just when you think the old rules don’t apply … they do. :-)
Also, you are right, it is one thing for the Fed to buy bonds from banks and quite another for it to buy directly from individuals. “Unknowable” isn’t a word I like, but as the collapse accelerates, I suspect we will just have to wait to get the answers to more and more questions.